Inflation is expected to surge back to 3% should the incoming Republican administration proceed with a potential universal tariff on imports, Goldman Sachs economist David Mericle said in a Sunday note.

The sweeping trade measure, floated by President-elect Donald Trump, could complicate the Federal Reserve’s efforts to keep inflation anchored at 2% and potentially slow the pace of rate cuts in 2025.

Could Tariffs Push Inflation Back To 3%?

Goldman Sachs estimates that a potential universal tariff would raise core personal consumption expenditures (PCE) inflation — the Fed’s favorite inflation gauge — by 0.9-1.2 percentage points (pp) at its peak, pushing inflation back to 3%.

“Our analysis of past tariffs suggests that every 1pp increase in the effective tariff rate raises core PCE prices by 0.1pp,” Mericle said.

Under the Republican baseline scenario, more targeted tariffs on imports from China and autos are likely to increase the effective tariff rate by 3-4pp, adding 0.3-0.4pp to core PCE inflation.

This would nudge inflation to 2.4% by December 2025. However, the implementation of a 10% universal tariff would triple this impact, causing a much sharper price surge.

While the inflationary bump is expected to be a one-time effect, such a move would force Fed policymakers to rethink the roadmap for rate cuts.

Tariff Risks: China, Autos, and Beyond

The baseline scenario includes a 20 percentage point (pp) increase in tariffs on Chinese imports—less for consumer goods and as much as 60pp for non-consumer items. Tariffs on auto imports, which were hotly debated during Trump’s first term, are also expected to return.

Goldman Sachs views these measures as disruptive but manageable, given their moderate inflationary impact. However, the specter of a 10%-20% universal tariff on all imports raises the stakes.

If enacted, such a policy could shave 0.75-1.25pp off GDP growth, depending on whether it is offset by additional fiscal stimulus, such as tax cuts.

Tax Cuts And Spending: Fiscal Stimulus Expected To Rise

On the fiscal front, Republicans are likely to extend the 2017 tax cuts, which are set to expire in 2025, according to Goldman Sachs.

The extension includes reinstating certain expired business investment incentives and adding modest personal tax cuts worth 0.2% of GDP.

Currently, the deficit sits at about 5% of GDP higher than historical norms for an economy operating at full employment. Meanwhile, the U.S. debt-to-GDP ratio is approaching record highs at 120%, raising concerns about fiscal sustainability.

Goldman Sachs warns that these imbalances could push bond yields higher, tightening financial conditions and creating additional headwinds for economic growth.

The Fed’s Balancing Act: What’s Next For Interest Rates?

Despite fiscal and tariff uncertainties, the Federal Reserve remains on track to cut interest rates in 2024 and 2025. Goldman expects the terminal rate to settle between 3.25% and 3.5%, higher than last cycle’s 2.25%-2.5%.

“Non-monetary tailwinds, like fiscal deficits and resilient risk sentiment, are offsetting the drag from higher rates,” said Mericle.

Yet, the expert warns that fiscal imbalances and potential tariff shocks could complicate the Fed’s strategy, especially if inflationary pressures or market volatility resurface.

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